1The conceptual framework

1.1The search for a conceptual framework
A conceptual framework, in the field we are concerned with, is as statement of generally accepted theoretical principles which form the frame of reference for financial reporting
The danger of not having a conceptual framework is demonstrated in the way some countries’standards have developed over recent years; Standards tend to be produced in a haphazard and fire-fighting approach. Where an agreed framework exists, the standard-setting body act as an architect or designer, rather than a fire-fighter, building accounting rules on the foundation of sound, agreed basic principles.
1.2Generally Accepted Accounting Practice (GAAP)
In individual countries this is seen primarily as a combination of:
●national company law
●national accounting standards
●local stock exchange requirements
2.The IASB’s Conceptual Framework
The 1989 Framework for the Preparation and Presentation of Financial Statements was replaced in 2010 by the conceptual Framework for Financial Reporting. This is the result of a joint project with the FASB
2.1Scope
The Conceptual Framework deals with:
(a)T he objective of financial statements
(b)T he qualitative characteristics that determine the usefulness of
information in financial statements
(c)The definition, recognition and measurement of the elements
from which financial statements are constructed
(d)C oncepts of capital and capital maintenance
2.2Users and their information needs
(a) Investors
(b) Employees
(c)Lenders
(d)Suppliers
(e)Customers
(f)Government
(g)The public at large
3. The objective of general purpose financial reporting
The Conceptual Framework states that: The objective of general purpose financial reporting is to provide information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.
The Conceptual Framework makes it clear that this information
should be prepared on an accruals basis.
Accruals basis: The effects of transactions and other events are recognized when they occur(and not as cash or its equivalent is received or paid)and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.
4. Underlying assumption
Going concern is the underlying assumption in preparing financial statements.
Going concern .The entity is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the entity has neither the intention nor the necessity of liquidation or of curtailing materially the scale of its operations 5. Qualitative characteristics of useful financial information
The Conceptual Framework states that qualitative characteristics are the attributes that make financial information useful to users. The two fundamental qualitative characteristics are relevance and faithful representation
5.1Relevance
Relevance. Relevant information is capable of making a difference in the decisions made by users. It is capable of making a difference in decisions if it has predictive value, confirmatory value or both.
The relevance of information is affected by its nature and its materiality
Materiality. Information is material if omitting it or misstating it could influence decisions that users make on the basis of financial information about a specific reporting entity
5.2Faithful representation
Faithful representation. Financial reports represent economic phenomena in words and numbers. To be useful, financial information must not only represent relevant phenomena but must faithfully represent the phenomena that it purports to represent.
To be faithful representation information must be complete, neutral and free from error.
5.2.1Substance over form
This is not a separate qualitative characteristic under the Conceptual Framework. The IASB says that to do so would be redundant because it is implied in faithful representation .Faithful representation of a transaction is only possible if it is accounted for according to its substance and economic reality.
5.3Enhancing qualitative characteristics质量特性
5.3.1Comparability可比性
Comparability is the qualitative characteristic that enables users to identify and understand similarities in ,and differences
among,rmation about a reporting entity is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period or date.
5.3.2Verifiability可验证性
Verifiability helps assure users that information faithfully represents the economic phenomena it purports to represent. It means that different knowledgeable and independent observers could reach consensus that a particular depiction is a faithful representation. 5.3.3Timeliness及时行
Timeliness means having information available to decision-makers in time to be capable of influencing their decisions .Generally; the older information is the less useful it is
5.3.4Understandability可理解性
Classifying, characterizing and presenting information clearly and concisely make it understandable.
6 The element of financial statements
Transactions and other events are grouped together in broad classes and in this way their financial effects are shown in the financial statements. These broad classes are the elements of financial statements
Elements of financial statements:
(a)M easurement of financial position in statement of financial
position
●Assets资产
●Liabilities负债
●Equity权益
(b)M easurement of performance in statement of profit or loss and
other comprehensive income
●Income收入
●Expenses费用
6.1Financial position
Asset. A resource controlled by an entity as a result of past event and from which future economic benefits are expected to flow to the entity.
Liability. A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
Equity. The residual interest in the assets of the entity after deducting all its liabilities.
Future economic benefit. The potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the entity. The potential may be a productive one that is part of the operating activities of the entity. It may also take the form of convertibility into
cash or cash equivalents or a capability to reduce cash outflows, such as when an alternative manufacturing process lowers the cost of production.
Obligation. A duty or responsibility to act or perform in a certain way. Obligations may be legally enforceable as a consequence of a binding contract or statutory requirement. Obligations also arise, however, from normal business practice, custom and a desire to maintain good business relations or act in an equitable manner.
6.2 Performance
Income. Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, Other than those relating to contributions from equity participants. Expenses. Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
7 Recognition of the elements of financial statements
Items which meet the definition of assets or liabilities may still not be recognized in financial statements because they must also meet certain recognition criteria.
Recognition. The process of incorporating in the statement of
financial position or statement of profit or loss and other comprehensive income an item that meets the definition of an element and satisfies the following criteria for recognition:
(a)i t is probable that any future economic benefit associated with
the item will flow to or from the entity and
(b)T he item has a cost or value that can be measured with
reliability.
8 Measurement of the elements of financial statements Measurement .The process of determining the monetary amounts at which the elements of the financial statements are to be recognized and carried in the statement of financial position and statement of profit or loss and other comprehensive income.
A number of different measurement bases are used in financial statements. They include:
●Historical cost
Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition.
●Current cost
Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently.
Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently ●Realisable(settlement) value
Realisable value .The amount of cash or cash equivalents that could currently be obtained by selling an asset in an orderly disposal.
Settlement value. The undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.
●Present value of future cash flows
A current estimate of the present discounted value of the future net cash flows in the normal course of business.
Example
A machine was purchased on 1 January20x8 for $3m.That was its original cost. It has a useful like of 10 years and under the historical cost convention it will be carried at original cost less accumulated depreciation. So in the financial statements at 31 December 20x9 it will be carried at:
$3m-0.3*2=$2.4m
The current cost of the machine, which will probably also be its fair value, will be fairly easy to ascertain if it is not too specialized. For instance, two year old machines like this one may currently be
changing hands for $2.5m, so that will be an appropriate fair value. The net realizable value of the machine will be the amount that could be obtained from selling it, less any cost involved in making the sale. If the machine had to be dismantled and transported to the buyer’ premises at a cost of $200000,the NRV would be $2.3m The replacement cost of the machine will be the cost of a new model less two year’s depreciation. The cost of a new machine may now be $3.5m.Assuming a 10-year life, the replacement cost will therefore be $2.8m
The present value of the machine will be the discounted value of the future cash flows that it is expected to generate. If the machine is expected to generate $500000 per annum for the remaining 8years of its life and if the company’cost of capital is 10%,present value will be calculated as:
$500000*5.335=2667500
*Cumulative present of $1 per annum for 8years discounted at 10%。